Surmodics Inc (SRDX) 2008 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen, Thank you for standing by. Welcome to the SurModics Fourth Quarter 2008 Earnings Conference Call. (Operator Instructions) This conference is being recorded today, Wednesday, November 5, 2008. I would now like to turn the conference over to Phil Ankeny. Please go ahead, sir.

Thank you, Brandy. Good afternoon, and welcome to SurModics Fiscal 2008 Fourth Quarter and Full Year Conference Call. Thank you for joining us today. I am Phil Ankeny, Senior Vice President and Chief Financial Officer.

Our press release reporting quarterly and full year results was issued earlier this afternoon and is available on our website at www.surmodics.com. We will also be using slides to supplement comments on our call today, and those are available on our website as well. Joining me on the call today is Bruce Barclay, President and Chief Executive Officer.

Before we begin, it is our duty to inform you that this conference call is being webcast and is accessible through the Investor Relations section of the SurModics website, where the audio recording of the webcast will also be archived for future reference. We expect the total call to last approximately an hour to an hour and a half.

As you can see on our Safe Harbor statement on slide 2, I will remind you that some of the statements made during this call may be forward looking. The 10-K for fiscal year 2007 identifies certain factors that could cause the Company's actual results to differ materially from those projected in any forward-looking statements made during this call. The Company does not undertake any duty to update any forward-looking statements as a result of new information or future events or developments.

Please be advised that during the call, non-GAAP financial measures will be used to provide information pertinent to our ongoing business performance. These measures are reconciled to the GAAP measures and are available in today's earnings press release.

At this point I will provide you with a brief overview of the topics that will be addressed during today's call. First, Bruce will make a few introductory remarks regarding our fiscal 2008 performance. Second, I will cover the fourth quarter and full year fiscal 2008 financial results. And then Bruce will return and highlight our achievements for the quarter and the year, review progress against our fiscal 2008 corporate goals, offer insights into our key growth opportunities, both from a near- and long-term perspective, and conclude with an announcement of our fiscal 2009 goals. And then lastly we will open up the call to your questions.

With that, let me turn the call over to Bruce.

Thank you, Phil, and thanks, everybody for joining us today. SurModics generated solid financial results and in particular excellent cash flow in fiscal 2008. As you can see on slide 3, for the eleventh consecutive year since our IPO in 1998, we achieved record revenue. During this span, SurModics' revenue has grown at a compounded annual rate of 26%. Our positive results in fiscal 2008 were also broad-based as we delivered record revenue in each of our three operating segments.

If you look at our non-GAAP results for the year, adjusting for the accounting treatment related to our Merck agreement, these results are even more impressive. In fiscal 2008, non-GAAP revenue was $111.2 million. And again on slide 4, you can see our track record of 11 consecutive years of growth in pro forma revenue.

Slide 5 is intended as a rough approximation of our pro forma revenue since our founding in 1979 through fiscal 2008. If you consider our revenue over the past five years compared with our revenue growth over the prior 24 years, since 1979, you can see a significant acceleration of our growth trajectory in the more recent period as we began to unlock the Company's true potential.

While we have much to be proud of in fiscal 2008, this has been a year unlike any other in our history. It has been a year of encouraging highs and disappointing lows. Great moments included successfully integrating two acquired companies, Brookwood Pharmaceuticals and BioFX Laboratories, both of which generated record revenue under the SurModics banner.

Two of our key technologies, our SynBiosys biodegradable polymer and our FINALE prohealing coating, commenced separate first in human clinical trials with two different companies. We also met the vast majority of our fiscal 2008 corporate goals as first announced in November of last year.

And, of course, after partnering with Merck on our I-vation platform last year, we jointly advanced the TA product into a Phase II trial and generated nearly $20 million in cash during the year. We will review these accomplishments in more detail in a few minutes.

On the other hand, we also experienced notable setbacks. Merck gave notice that it is terminating the agreement with SurModics as part of their company-wide cost-cutting efforts. Also while significant progress has been made, we were unable to finalize negotiations for a second ophthalmology license. And although many of our licensed partners in the DES space made good progress and saw success, CYPHER sales continued to erode.

With all of these highs and lows, it is important to recognize that one thing has not changed about SurModics. We are a technology-rich Company with an incredibly talented group of committed employees, and a dedicated, experienced management team that is more focused than ever on meeting unmet clinical needs. Moreover, we are a financially healthy Company and retain significant resources.

Our business is highly profitable, generates significant cash flow. We have a strong balance sheet with virtually no debt. Our technologies are incorporated into more than 100 product classes with FDA or other regulatory approval. We have a pipeline of nearly 200 projects progressing toward commercialization, and we are partnered with many of the world's leading pharma, medical device, and life science companies.

The confidence we have in our business is reflected in today's presentation. Later on in our prepared remarks we will provide further insight into our key growth opportunities that reflect the optimism we have in our business to succeed over the long term. We will also review the progress we have achieved in this business over the past five years, which was the last time the stock traded at recent levels.

During the course of the call, we intend to convey what we see every day -- great opportunities for our Company, our people, and our technologies. We believe the recent setbacks will be more than offset by near- and long-term opportunities in our pipeline. And, as we look forward, our ability to exceed expectations in the past have become a great source of satisfaction which we look forward to repeating.

With that, I'll turn the call back to Phil.

Thank you, Bruce. I will begin by providing an overview of fourth quarter financial results and follow that with specifics on discrete line items. Next, I will discuss significant revenue drivers and break down revenue by business segment. I will also review full-year financial results. And, finally, I will discuss expenses and review our balance sheet and cash flow.

Fourth quarter revenue was $23.2 million, a 9% increase from $21.3 million on a year-over-year basis. This total includes a record $6.4 million in revenue from Brookwood Pharmaceuticals and a record $1.3 million from BioFX Laboratories, both of which we acquired in the fourth quarter of fiscal 2007.

As we have said before, going forward we will no longer break out the revenue contributions from these businesses as we have now completed a full year of operations with them as part of the overall SurModics enterprise. As you can see by these results, the integration of Brookwood and BioFX has gone exceptionally well.

Let me now turn to our fourth quarter results. Moving down the income statement, the Company reported operating income of $5.3 million. In non-operating activities we recorded a one-time non-cash loss on our investment in OctoPlus of $4.3 million, or approximately $0.24 per diluted share.

As you may recall, OctoPlus is a Dutch drug delivery company from whom we have licensed some biodegradable polymer technology and in whom we have a strategic investment. OctoPlus has made excellent progress with their lead product, Locteron, a sustained release drug formulation for the treatment of hepatitis C. However, the market for European biotech companies has been challenging, and the market value of OctoPlus has declined significantly this year. While we continue to hold our investment in OctoPlus, we believe it was prudent to take an impairment loss this quarter.

Since the close of our fiscal year, OctoPlus signed a new multi-million-dollar licensing deal for Locteron with their partner Biolex, which we are told has alleviated much of the financing risk the company was facing.

Taking into account the impairment loss, we generated a net loss for the quarter of $0.8 million. Diluted earnings per share was a loss of $0.05.

I will now provide a brief review of our results on a non-GAAP basis, adjusting for the accounting for the Merck agreement and excluding the impairment loss I just discussed. Please refer to the supplemental tables in our press release.

Non-GAAP net income was $3.6 million, and diluted earnings per share was $0.20. Let me comment briefly on the accounting treatment related to our Merck agreement. As we discussed in the call we hosted in September, SurModics was informed by Merck on September 16, that following a strategic review of its business and product development portfolio, Merck intends to terminate the collaborative research agreement between our companies. Under the agreement, termination take effect 90 days after notice to terminate the contract has been provided to SurModics. Accordingly, the agreements remain in full force and effect until the 90-day notice period lapses in December.

In the fourth quarter we continued to recognize revenue under EITF 00-21 on the 16-year schedule we have used in the past. Revenue from Merck in the fourth quarter was $637,000, and we billed an additional $769,000 to Merck in the quarter, bringing the deferred revenue balance associated with Merck to $34.8 million.

Merck's decision to terminate the agreement also triggered an additional $9 million payment to SurModics, which will be recognized upon the effectiveness of the termination. Also in the first quarter of fiscal 2009, once the termination takes effect in December, we expect to recognize the remaining deferred revenue. Accordingly, our first quarter results likely will include the recognition of approximately $44 million in revenue from Merck in our GAAP reporting.

As has been the case in recent quarters, our earnings growth did not keep pace with revenue growth primarily because of the changing mix of revenue sources and the accounting treatment required under the Merck agreement. Recall that we have recognized all of the development expenses as they were incurred, even though revenues are amortized over time. The changing revenue mix is illustrated on slide 6.

Shifting gears a bit, I will now discuss the CYPHER Sirolimus-eluting Coronary Stent from Cordis Corporation, a Johnson & Johnson company. As a reminder, the CYPHER stent has been on the market in the United States for more than five years. During that period it has produced the longest term clinical data of any drug-eluting stent and has generated very strong revenue and cash flow for SurModics.

J&J reported worldwide CYPHER stent sales of approximately $289 million, down 23% on a reported basis year-over-year. Recall that Abbott received approval for Xience, and Boston Scientific received approval for Promus in July.

Despite the decrease in sales, J&J estimates that the CYPHER stent retained 22% market share in the United States, and 30% market share outside the United States during the quarter. Encouragingly, J&J has reported that total drug-eluting stent penetration rates in the US have rebounded from roughly 63% to approximately 70% versus a year ago.

Later in the call, Bruce will discuss our expectations for how the recent approval of Xience and Promus will impact the drug-eluting stent market in coming quarters, and how SurModics is participating in promising next-generation drug-eluting stent technology in this $4 billion plus market.

As discussed last quarter, while we expect greater competition to affect results for CYPHER going forward, recall that our agreement with J&J provides for the payment of minimum royalties as long as the agreement is in effect. In other words, even if competition sharply erodes CYPHER's market share, SurModics will continue to receive significant minimum royalties.

We have long anticipated this eventual downturn in CYPHER sales and the diversification strategy we pursued to counter this eventuality is clearly bearing fruit. That is evidenced by the continued strong growth experienced by our remaining businesses. In fact, in fiscal 2008, total revenue from J&J, which includes other products besides CYPHER, constituted 20% of total revenue.

To put this figure in perspective, please refer to slide 7. As you can see, this figure is down from 33% in fiscal 2007 and 47% in fiscal 2006. You can also see that this percentage peaked in fiscal 2004 at 52%.

In the four years since then, our non-J&J revenue, essentially the rest of our business, has more than tripled, growing at a 34% compound annual growth rate. Our sustained ability to generate strong revenue growth despite declining contributions from CYPHER sales demonstrates the benefits achieved by the successful management of our broad and diverse portfolio of technologies.

Next, I will review results across business segment line. The Drug Delivery segment generated revenue of $10.5 million in the quarter, a 34% increase year-over-year, but down 2% sequentially. The increase from the year earlier period reflects strong revenue growth from Brookwood, which offset the impact of the 23% year-over-year decrease in CYPHER sales.

Moving on to the Hydrophilic and Other operating segment, we generated revenue of $8.2 million during the quarter, up 5% year-over-year, and up 4% sequentially. The strongest contributor to this increase was growth in royalties and license fees.

Our continued growth in this segment illustrates the substantial customer traction that exists for SurModics technologies, and the continued value of our diversified portfolio of customers.

And, lastly, revenue for the In Vitro segment was $4.5 million, down 19% year-over-year and down 20% sequentially. Growth in product sales including BioFX, was not sufficient to offset the decrease in royalties from Abbott and GE Healthcare.

Recall that a year ago GE converted their license agreement to nonexclusive, and accordingly, the minimum royalties have decreased. Now that we have purchased the microarray business from GE, the royalty stream has stopped, while we are now able to capture more of the product margin.

Now, let me discuss the royalty impact of our Abbott license agreement. As you may recall, SurModics licensed several patents for lateral flow amino assay technology to Abbott in 1989. That license agreement has generated a strong royalty stream for many years. In fiscal 2008, total royalty revenue related to the Abbott agreement was approximately $8.7 million. In the fourth quarter, however, the amount was $1.2 million, obviously much lower than the first three quarters of the year.

As we have discussed in the past, the patents expire in December 2008. However, since we report royalties on a lag, royalty revenue should continue through the second quarter of fiscal 2009. Based on these figures, investors can assess the impact of the patent expiration on fiscal 2009 results and beyond.

Let's turn now to full year results. Total revenue for fiscal 2008 was a record $97.1 million, a 33% increase from $73.2 million in 2007. We achieved record revenue in all three operating segments for fiscal 2008. Drug Delivery segment revenue increased 66% to $43.9 million from $26.5 million. Hydrophilic and Other segment revenue increased 20% to $31.9 million from $26.5 million in 2007. And In Vitro segment revenue was $21.2 million in fiscal 2008, up 5% from $20.2 million in 2007.

On a revenue component basis, total royalties and license fees decreased less than 2% to $51.8 million from $52.7 million in fiscal 2007. Growth in royalties and license fees from the rest of our diversified portfolio nearly offset the significant impact of the 23% decrease in CYPHER sales.

Product sales increased 48% to a record $20.1 million from $13.5 million in fiscal 2007. Lastly, Research and development revenue more than tripled to a record $25.2 million in fiscal 2008, compared with $6.9 million in 2007.

The Company reported operating income of $27.3 million, net income of $14.7 million, and diluted earnings per share of $0.80. Adjusting revenue for the accounting treatment of the Merck agreement and excluding the impairment loss on our investment in OctoPlus, as well as the prior years in process research and development charge in connection with our acquisition of Brookwood Pharmaceuticals, non-GAAP results were as follows.

Fiscal 2008 total revenue was a record $111.2 million, compared with $93.8 million in fiscal 2007. Operating income was $41.4 million in fiscal 2008, compared with $46.1 million last year.

Fiscal 2008 net income was $27.7 million, compared with $31.8 million in fiscal 2007. Diluted net income per share was $1.51 in fiscal 2008, compared with $1.75 last year, reflecting Merck's upfront payment in 2007 and the changing revenue mix, among other factors.

Slide 8 illustrates our history of pro forma earnings per share.

Next, I will turn to a review of operating expenses. SurModics continues to invest heavily in R&D as we expand our technology leadership and support our culture of innovation, as well as providing support for our multiple customer projects. In fiscal 2008, we dedicated 42% of revenue to R&D. Overall, R&D expense constituted 66% of total operating expenses excluding product costs.

We are also continuing to grow our technical team adding capabilities to better support our customers today and in the future. The addition of Brookwood and BioFX, combined with the organic hires we have made in our legacy business, is reflected by total R&D expense of $40.5 million, up 42% from last year.

SG&A expense rose 53% compared with last year. Much of this increase is associated with the addition of Brookwood and BioFX, as well as the expansion of our organization to support our growing business. Also included in these expenses was amortization of intangibles from the Brookwood and BioFX acquisitions totaling approximately $1.2 million.

Now let's turn to the balance sheet, which remains healthy and a source of significant strength in these difficult economic times. As of September 30, SurModics had a cash and investments balance totaling $72 million. Cash flow from operations was $16.2 million in the fourth quarter, and $38.8 million for the full year.

Slide 10 illustrates our strong record of cash flow generation. These results reflect the ability of our business model to generate cash flow even before products are commercialized, and in spite of our inability to recognize this cash immediately as revenue in certain situations, such as under the Merck agreement.

We are also pleased with our decision earlier this year to reduce our exposure to real estate by accepting an early paydown of the $6 million note receivable from the sale of our former Bloomington, Minnesota facility.

We continue to be active in the deployment of capital with a goal of enhancing shareholder value. As summarized on slide 11, since announcing our new share repurchase program in November 2007, we have purchased approximately $300,000 shares of SurModics stock for $12.7 million. We were not able to purchase any shares following the announcement of Merck's intent to terminate our agreement, as we were in a customary blackout period.

Our share repurchase program reflects our strong confidence in our near and long-term prospects, and our belief that SurModics' stock is undervalued.

In addition, SurModics has been active in business development for several years, as shown on slide 12. More recently, we acquired the Microarray business from GE Healthcare and a portfolio of intellectual property and collaborative drug deliver projects from PR Pharmaceuticals as we announced just yesterday.

Moreover, SurModics has invested in its own infrastructure with the April 2008 acquisition of an additional facility in Birmingham, Alabama. As discussed previously, this facility will expand Brookwood's capacity for research and development activities and CGMP manufacturing of drug delivery products for pharmaceutical and biotechnology customers.

Existing and prospective customers have reacted very favorably to the new facility, which is under construction and remains on schedule and within our expected budget. We believe our activities and accomplishments in fiscal 2008 have strengthened our ability to build long-term shareholder value and are confident in the future of our Company.

With that, I will now turn the call back to Bruce.

Thank you, Phil. Let me start by reminding everyone why we're so optimistic about SurModics' ability to provide sustainable growth over the long term, and I refer you to slide 13. First we have a unique and evolving business model with a proven ability to both grow and diversify revenue. Second, we also can derive value from solving customer problems in many different ways, thereby creating multiple revenue and generating opportunities.

And, finally, we have a track record of strong financial results and effective capital allocation. We'll talk about our growth opportunities today.

Before I discuss 2009 and beyond, I want to reflect on the accomplishments we achieved this past year. I've broken down our fiscal 2008 accomplishments into financial and nonfinancial metrics.

First, Phil's already highlighted our financial results, which are summarized on slide 14, so I won't dwell on them here. We achieved record revenue for the eleventh consecutive year, even though only $3.2 million from Merck was reported as GAAP revenue for the year. Our non-CYPHER business continued to grow, up 58% year-over-year.

We achieved record revenue in all three operating segments, and we generated strong cash flow and pro forma earnings.

Looking at our non-financial results, you can see on slide 15 that we had a very productive year in many parts of our Company. We'll review these shortly. I do want to congratulate and thank your exceptional employees for all their hard work in fiscal 2008.

I want to focus today on the significant growth opportunities we see in our business going forward, in particular over the next couple of years. These opportunities are listed on slide 16 and include Brookwood Pharmaceuticals, Ophthalmology, Drug-Eluting Stents, Hydrophilic and other surface-modified technologies, our In Vitro business, and our growing and diverse pipeline, as well as the investments we are making to develop and acquire new technologies for the benefit of our customers. Let me address a few of these growth opportunities over the next few slides.

I'll start by reviewing a few opportunities representing our Drug Delivery operating segment. This business delivered record revenue of $43.9 million in fiscal 2008, generating impressive growth since 2004, as shown on slide 17. Building off this strong foundation, our ability to drive drug delivery growth has been greatly enhanced by Brookwood Pharmaceuticals, which provides site-specific and systemic drug delivery solutions to companies developing improved pharmaceutical products, as well as access to many new large markets.

Brookwood, which we acquired in August 2007, generated record revenue in fiscal 2008, highlighting the strong customer interest in its technology. Revenue has been driven by customer supported R&D, product manufacturing, clinical trials, and polymer sales. Moreover, as customer projects move along in the development cycle, there remains significant potential from royalties and license fees which we expect to realize within the next 12 to 24 months.

Brookwood's track record of generating strong growth is impressive and will be an engine for growth going forward. For example, in fiscal 2008, Brookwood generated $20.5 million and grew 35%, compared to Brookwood's full year fiscal 2007 results. If you go back to when it was first spun out as a standalone company from SRI, as you can see on slide 18, Brookwood has grown its revenue from $6.1 million in fiscal '05 to $20.5 million in fiscal 2008. This represents a compound annual growth rate of 49%. While Brookwood's current revenue base does not yet include any royalties, once it does, we believe the true value of this business will be realized.

The integration of Brookwood into SurModics has gone well. Our technical teams are driving excellent synergies by combining the two bodies of technology. The combination of Brookwood microparticle technology with SurModics polymers provides a broad array of drug delivery technologies and capabilities to solve virtually any polymer-based need required by our customers.

This is important, because the systemic drug delivery in pharma markets are larger than the device-based coatings market. We can now address the needs of a larger and almost entirely new customer base. For example, as we gain more exposure to markets such as oncology, central nervous system disorders and diabetes, we are positioning our Company to take a leadership role in market opportunities previously unavailable to SurModics.

In 2008, Brookwood signed a new development agreement with a top 50 pharma company for a product in the oncology space. Also encouraging are developments relating to Brookwood's license customer, Ambrilia Biopharma, which has announced positive results for its Phase III study of a proprietary formulation of Octreotide to treat acromegaly, a market estimated at approximately $1 billion.

Ambrilia plans to submit an application to the FDA by the end of 2008, with a goal of approval and commercialization in the US by the end of 2009. If this timetable tracks the plan, royalties could flow to Brookwood as early as fiscal 2010. Beyond Ambrilia, Brookwood has multiple later stage opportunities including Clinuvel, which is conducting clinical trials for multiple indications including a Phase III trial for one.

We expect to sign license agreements with additional Brookwood customers going forward, as is the case for SurModics' legacy business, potential license field could be structured to include milestone payments in advance of royalties. This is one of the significant advantages of our business model.

The final point I would like to make on our Brookwood business relates to the press release we issued just yesterday. We are very pleased to have acquired important proprietary drug delivery technologies in collaborative customer programs from PR Pharmaceuticals. And the benefits of the deal are summarized on slide 19.

The proprietary technologies we acquired have broad applicability and address key needs, enabling the delivery of injectable drugs including proteins, with microparticles through smaller diameter needles compared to competing technologies. The use of smaller diameter needles for microparticle injection is particularly relevant in ophthalmology. Also, the use of smaller needles is an advantage in many other applications requiring subcutaneous or intramuscular injections, and in particular where patient self-administration is desired.

Protein and other large molecule therapeutics are a strategic interest to many biotechnology and pharmaceutical companies, but pose significant challenges for drug delivery.

The PR Pharma technologies will complement those or SurModics and our Brookwood business unit, and broaden the overall technology portfolio for the benefit of current and future customers. We expect to immediately generate revenue from this acquisition in three ways.

First, new customer projects that are being transferred from PR Pharma to us. Second, by supporting PR Pharma directly on their exciting new sustained release basal insulin product known as InsuLAR. And third by applying PR Pharma's proprietary technology to existing and new customer projects at Brookwood, especially where these projects can benefit from even smaller needle sizes for injection. We expect this transaction to be accretive in fiscal 2009, excluding any one-time charges in connection with the transaction.

Moving on to other near-term opportunities, I want to highlight our Ophthalmology business, which continues to be an important driver of our revenue diversification strategy. SurModics scientists and engineers are busy on ophthalmology development projects with numerous customers for back of the eye and front of the eye diseases. These projects leverage our multiple drug delivery platforms and polymer matrix technology as depicted on slide 20 for sustained delivery of customers' proprietary drugs to the eye, including both large and small molecule compounds.

The stronger customer demand for our research and development services reinforces the opportunity we see in sustained drug delivery applications in ophthalmology.

As you know, we recently announced that one of our ophthalmology partners, Merck, gave notice of its intent to discontinue its license and research collaboration agreement with SurModics. It's important to note that Merck's decision to discontinue the program was prompted by a strategic review of its business. In its recent earnings release, Merck announced the company's intent to cut more than 10% of its global work force and selected projects as part of a broad-based restructuring effort. Unfortunately, we were impacted by that strategic decision.

Importantly, Merck's decision was not based upon concerns about safety, efficacy or performance of the I-vation TA product, the I-vation platform, or any of SurModics other sustained drug delivery systems. In fact, the clinical data generated to date for the I-vation TA product strongly supports its safety and more generally that of the I-vation sustained delivery platform.

Dr. Praveen Dugal presented our two-year Phase I clinical trial data for this product at the American Society of Retina Specialists Meeting last month, and those conclusions are presented on slide 21. As you can see, our Phase I study has demonstrated an excellent safety profile and a sustained clinical effect. While we were disappointed with Merck's decision, the collaboration agreement was highly beneficial to SurModics from both a financial and technology development perspective.

It's interesting to note that our stock price is substantially lower today than it was before we signed and announced our agreement with Merck in June of 2007. This pullback has occurred even though no one can dispute that our Company is much better off having signed that agreement and generated significant financial rewards, as well as furthering development of our technology over the past 16 months.

For example, with the money derived from operating cash flow and from Merck, we acquired two revenue and profit-generating companies in Brookwood and BioFX, both of which hold great promise for the future. We also completed two asset acquisitions including proprietary intellectual property and collaborative drug delivery projects from PR Pharma, and the CodeLink Microarray business from GE Healthcare.

In addition, we have repurchased our stock in the open market and invested in facilities to support the continued growth of our business.

Lastly, our technology and capabilities have grown substantially, particularly as it relates to our ability to deliver large molecules over an extended period of time. From a competitive standpoint, this makes us unique, as does the experience we gained in initiating a Phase II clinical trial with FDA.

Our agreement with Merck illustrated an important aspect of our business model, the ability to generate substantial amounts of cash even before a commercial product reaches the market. As a result of our Merck agreement, we generated over $47 million in cash within approximately 16 months. Our team has discussed what we've learned from this situation and the most valuable lesson is that even large companies need to revisit their priorities on occasion. Even when you've done everything right and the technology is developing according to plan, decisions such as the one made by Merck are not uncommon, particularly in today's difficult economic environment.

One conclusion you might draw is that we should shy away from doing business with companies like this. However, our conclusion was just the opposite. We need more large company partners and multiple large customer opportunities. Developing these relationships is exactly what we're trying to do with Brookwood and its pharma customers, and with our ophthalmology business as further supported by the new customers we are inheriting with the PR Pharma transaction. Multiple shots on goal further protect our downside and provide greater upside for the benefit of our shareholders.

We remain committed to and confident in the future of ophthalmology. We continue to have numerous customer development programs in Ophthalmology evaluating several different drug delivery programs including I-vation, microparticles, and biodegradable implants. We've made strong progress in each. We believe Ophthalmology will remain a strong contributor to SurModics' revenue diversification in the years to come.

Not to be forgotten, our efforts in orthopedics continue to show promise as well. We remain active in this market and are progressing customer supported drug delivery projects with multiple orthopedics companies.

Moving on, the DES market remains an important area for us. As you can see on slide 22, we have three different types of technology that partner with companies in this space, and all offer good ways to participate in an existing $4 billion plus market.

As you saw last week, we announced a license with our tenth company in the DES space, Elixir Medical, for use of our hydrophilic coating technology on their stent delivery system. Elixir has generated a lot of excitement within interventional cardiology as it is developing a variety of bare metal, drug-eluting, and fully biodegradable stents, and has multiple clinical trials underway. Our royalty rate with Elixir, like many of our DES partners, is higher than the royalty rate we have on CYPHER for the drug release polymer.

There were many highlights we achieved in DES in fiscal 2008, and a few are listed on slide 23. SurModics launch of the Endeavor DES in the US satisfied one of our cardiovascular objectives. CardioMind initiated a first in human clinical trial with a next-generation drug-eluting device incorporating SurModics technology. This goal was achieved with the SynBiosys biodegradable drug delivery polymer system. In addition, we are pleased that in September, Nexeon Med Systems, formerly Paragon IP, successful initiated a first in human trial for their PROTEX Coronary Stent System. Dr. Mark Bates, interventional cardiologist and founder of Nexeon, presented the exciting data on their PROTEX Prohealing Coronary Stent at TCT a few weeks ago.

Lastly, we have other DES-partnered projects in the pipeline which we have not yet disclosed, but which give us further optimism about this opportunity.

As I mentioned earlier, CYPHER results have already been significantly impacted by the recent entries of Xience and Promus in the US. As part of our strategic outlook, we expect our revenue related to DES to bottom in 2009 and increase thereafter. Recall that we participate in DES with drug delivery polymers, hydrophilic coatings, and various technologies to address thrombosis and restenosis, such as Prohealing.

In addition, while we have been realistic in our estimates regarding CYPHER going forward, we look forward to working with Cordis on future products including CYPHER Elite, for which they have published an anticipated PMA filing date in 2010, and NEVO, which with an anticipated CE Mark filing expected in 2009, and a PMA filing in 2011. Both of these products contain technologies license from SurModics.

Taking into account all these customer activities, we believe that the best days for DES revenue are actually in front of us, as we expect to exceed our historic revenue peak from DES sources, which was achieved in fiscal 2006 within the next five years as a result of our increased diversification and customers in the ES, and better financial terms with several customers.

Our Hydrophilic and Other operating segment continues to quietly generate exceptional results, and this robust business segment offers exciting potential for us going forward. As you can see from slide 24, this business has delivered exceptional growth over the last five years. In fact, more than doubling in this period. As our first-in-class technology coupled with our outstanding service and our preferred equipment provider, Op River Technologies, capture new customer business. We continue to see this business growing well into the future.

Turning now to our In Vitro business segment. As you can see on slide 25, our revenue growth in this operating segment has been strong over the past five years, increasing 2.5-fold in this time. We've made meaningful progress in advancing our technology platforms for in vitro diagnostics. The diagnostic product business represents an important growth opportunity as well as a hedge to SurModics therapeutic focused businesses.

Over the past three years we've successfully executed our strategy to significantly broaden our offering to in vitro diagnostic customers. As a reminder, the first step in this process was to sign a distribution agreement with DIARECT, which we did in July 2006. That enabled us to leverage our sales force and provide both protein stabilizer and antigen components of diagnostic tests.

In August 2007, we acquired BioFX, adding a strong product line of color metric in chemiluminescent substrates, which has enabled SurModics to simultaneously market three key components of diagnostic test kits. This positions us as a leader in the space with one of the broadest offerings in the industry.

Our recent acquisition of the CodeLink microarray business from GE Healthcare has added a greater depth to our offerings by allowing us to capture the margin that GE was previously receiving as a distributor of this technology, generate new customers and create new products leveraging our core technology.

Finally, sales of cell culture products developed in concert with Donaldson and Corning continue to grow albeit slowly, and Corning continues to support and believe in the potential of these products.

Beyond some of the highlighted opportunities I just mentioned, we have a whole host of opportunities that continue to diversify our revenue streams and present solid growth potential. With regard to our business -- we regard our business as a portfolio of opportunities with more than 100 licensed products generating royalties, and nearly 200 projects in our pipeline not yet on the market as a significant driver of future value.

On September 30, we had a total of 101 licensed customers, several with multiple licenses, compared with 92 in the prior year period. As shown on slide 26, our customers launched 11 product classes in fiscal 2008, exceeding our goal of 10 in 61 product classes over the past five years, more than any other five-year period in our history. SurModics had 103 licensed product classes on the market generating royalty revenue, compared with 100 a year ago.

Our pipeline still shows significant potential, as slide 27 illustrates. Total number of licensed products not yet launched was 105, up from 94 in the prior year period. Major nonlicensed opportunities stood at 88, compared with 75 a year ago.

In total, the Company had 193 commercial products in development. As these numbers in our paid R&D for the full year suggest, the magnitude of R&D work we are doing on behalf of customers is a testament to the value that they place on our capabilities in addition to demonstrating the significant potential value we see in our robust pipeline.

And, again, looking at the impressive five-year trend, our pipeline opportunities have more than doubled in the last five years.

Turning to licenses, in fiscal 2008, we signed 23 new agreements, exceeding our goal of 18 for the year. As you can see on slide 28, over the past five years we have signed 108 new license agreements, again, more than any other five-year period in our history.

Finally, we generate significant customer interest as a result of our commitment to and continuing investment in creating new technologies from our R&D efforts. SurModics has long articulated and executed a strategy of accelerating our technology leadership and broadening our platforms.

Over the past year we have made significant progress in both of these areas, and are gratified to see the fruits of our efforts positively impact results. We spent a record $40.5 million in R&D in fiscal 2008, or nearly 42% of revenue, and in the process continued to generate proprietary technology from internal projects and customer supported projects. As slide 29 illustrates, this investment has grown steadily over time.

There are a number of exciting areas we are investing in, and slide 30 lists but a few. These areas of research represent topics of interest to our customers and other thought leaders. We believe pursuing technology to address these markets has the potential to keep us at the forefront of the use of biomaterials in healthcare for a long time to come.

Now I'll review the final results of our progress against our fiscal 2008 goals, which were unveiled at our Investor Day last November. On slide 31 through 37, we list our 15 goals. And, again, through the hard work of our employees, we have achieved 13 of them in the year. I've already touched on many of these goals, so I won't repeat them here.

Our ability to achieve these milestones has, in my opinion, favorably positioned the Company to create significant value for SurModics and our shareholders. While we were not able to sign and announce our second ophthalmology license as hoped, our work with multiple paying customers in this important area continues.

As discussed in the past, the decision and timing associated with entering into a license agreement with another company for use of our technology is based upon -- is based on when the customer chooses to move forward. Some do so early on before they have committed a lot of time and money to the technology with us, and when the risk of ultimate success is greater but the license terms are typically lower. Others prefer to wait until they have advanced further into the development process, reducing risk and gaining further comfort that our technologies will increase their changes of ultimate success.

The cost of waiting and reducing risk is that the eventual license terms typically will be higher. In the complex drug development programs of the kind we're involved in with our customers, the preclinical development activities can take years. At the moment we have multiple customers who prefer to further advance the technology and pay more later.

While there are no guarantees in science, if we are successful in our efforts, and certainly our track record suggests we will be, ultimately we will be rewarded.

As we run this business with a long-term perspective, we are perfectly content to continue developing this technology with our partners and generate even stronger long-term rewards.

We're pleased to share with you today some perspective on our financial performance over the next five years. In providing this perspective on our financial performance, we will confine our commentary to non-GAAP measures of revenue and earnings, which adjusts for agreements with EITF 00-21 implications, as you saw with Merck, as well as an one-time charges in connection with acquisitions, asset impairments and the like.

As we have articulated in the past, we expect fiscal 2009 to pose some challenges from a growth perspective for SurModics. New competition to CYPHER will put increased pressure on our royalty streams from CYPHER. The upcoming expiration of our diagnostics patents under the Abbott agreement will result in a decrease in that royalty stream in fiscal 2009, and no revenue beyond fiscal 2009. The expected termination of our market agreement certainly has an impact on our outlook in 2009 as well.

Lastly, now that we have passed the anniversaries of our acquisitions of Brookwood and BioFX, our year-over-year comparables will no longer get any lift from those acquisitions. Factoring all of this into our analysis, and particularly in light of the difficult economic environment, we expect fiscal 2009 revenue and EPS, again on a non-GAAP basis, to be roughly flat compared with fiscal 2008.

GAAP revenue and GAAP EPS will, of course, will be substantially higher given the expected acceleration of deferred revenue from Merck, and this will further stand out since the expense from Merck was accounted for previously when it was incurred.

Beyond fiscal 2009, however, we see strong long-term growth potential for the many reasons we articulated this afternoon. Let me walk you through a few of the key assumptions underlying our objectives. We assume continued growth in our Brookwood Pharmaceuticals business, and yesterday's announcement of additional technology and customers from PR Pharma provide even more confidence in the growth of this business going forward.

Our ophthalmology business remains an important growth driver. Importantly, in looking at our pipeline for Brookwood in ophthalmology, we have significantly risk adjusted potential revenue associated with the early stage projects to account for the higher risk of completion.

On the DES front, again we believe the best years are ahead of us, not behind us, as expect to exceed a prior peak and annual DES revenue within the next five years. In addition, we assume positive organic growth on our core businesses such as hydrophilic technologies. Our in vitro business has strong prospects for increasing sales of a growing array of products.

Finally, our diverse pipeline coupled with our continued investments in R&D give us great optimism. It's also important to highlight the fact that our assumptions do not reflect extraordinary circumstances, such as a long-term protracted recessionary economic environment or a major overhaul of US healthcare system. Obviously, significant change to the regulatory environment, reimbursement rates and the like would significantly impact companies' business models through the healthcare space. A sustained recessionary environment could similarly impact our customers and our business.

We strive for high quality growth over the long term as we take advantage of new market opportunities in cardiovascular, ophthalmology, systemic drug delivery, and in vitro diagnostics, among others. Our financial objectives also contemplate our continued focus on improving opening leverage while at the same time continuing to invest in our infrastructure and internal technologies. In addition, we believe our revenue mix will trend in a more profitable direction over time.

In summary, we believe our growth prospects remain strong. We have taken important steps toward building an enduring great company.

At this point we'll conclude with SurModics fiscal 2009 objectives. As in previous years, these goals are designed to offer insight into how we manage our business and to provide a review of the Company's future opportunities. These goals are aspirational in nature as we often don't control all the timing with our customer-dependent goals. Looking first to slide 39, we expect to sign 18 new licenses with our customers, and we expect our customers to launch 10 new product classes in fiscal 2009.

Finally, we would expect to return at least one-third of our operating cash flow to shareholders. We remain committed to our share repurchase program, and at recent prices and with our strong balance sheet, I expect us to aggressively purchase shares when we can.

On slide 40, we identify four additional fiscal 2009 goals. First, to sign a new customer license with SurModics drug delivery technology within Ophthalmology. Second, sign a new customer license using SurModics drug delivery technology outside of Ophthalmology. We expect our Brookwood business unit to sign two customer licenses in fiscal 2009.

And, lastly, we expect to initiate a human clinical trial for a product using SurModics drug delivery technology by one of our customers.

In closing, SurModics continues to demonstrate leadership and expertise in the application of biomaterials to the healthcare industries for the ultimate benefit of patients around the world. Those attributes enable us to exploit the opportunities presented by the convergence of drugs and devices. Importantly, we are successfully executing on our strategy to expand our platform in technology leadership and further diversify our revenue streams, while at the same time consistently delivering strong financial performance.

I'm excited about our future and confident that we can deliver sustainable long-term shareholder value for our customers.

Operator, that concludes my prepared remarks. We'd now like to open up the call to any questions.

Thank you, sir. We will now begin the question-and-answer session. (Operator Instructions) And our first question comes from the line of Ross Taylor with CL King. Please go ahead.

Hi. I've got a couple of questions. I'll try to keep them brief. First of all, why did the Abbott revenues drop so sharply during the quarter? I just wondered if there was any kind of explanation for that? And, also, I think you said that the royalty revenues from Abbott were $8.7 million through the first three quarters of the fiscal year. And I just wondered, does all of that end up going away when those patents expire, or just part of it?

Thanks for your question, Ross. Let me try to address that. First of all, just the numbers $8.7 million is the full fiscal year number. And so the $1.2 million was just the fourth quarter portion of that. And so obviously the first three quarters were much stronger.

Probably the biggest factor impacting the results in the fourth quarter are seasonality, where you're starting to see summer months of the flu and strep business that is a winter peaking kind of product line, and that's in place for several of the sublicensees that are there. But more particularly there were some adjustments that one of the sublicensees was taking against some previous results, and so that was the most significant component that we saw there.

Okay. And I guess also part of my question was my understanding was not all of those Abbott royalties are going to go away when the patents expire in December, or do you ultimately expect all of those would essentially go away after fiscal 09?

So, the timing will go somewhat like this, where the patents expire in December, and so all sales of customer products that are transacted before December are royalty bearing. And so we will have royalty revenue from Abbott in the first quarter and then again in the second quarter of fiscal 09. There's a chance that some could spill beyond that, but that's no guarantee, just because we don't know when they'll report those royalties to us.

Okay.

And any other reminder, of course, is that there is amortization of the actual Abbott acquisition deal that we did several years ago, and that will actually be included in Q1 results, but stops with the patent expiration. So, there will not be any amortization charge in the second quarter.

The last point that I would make is what you'll see in our 10-K ultimately is that as you know we typically disclose any 10% or north of 10% customers, and so J&J is in that and Abbott is in that. Last year Abbott was 16% and this year they'll be 10%. And so if you do that math, there's obviously other revenue from other Abbott products, mostly in the Abbott vascular arena, that do generate revenue for SurModics. What I was highlighting was exclusively the diagnostics royalties that are included in the In Vitro segment.

Okay. That helps a lot. And also with regards to the GE products that you bought back in recently, do you expect you can very quickly ramp those up so that you're at a revenue and income level that's equal to where it was for those products when GE was marketing them?

Well, we certainly hope to. We're not I think at liberty today to be that specific, but remember these are products that we have great familiarity with, going back to 1999. We've made them for a long time. We've gotten back certain rights a couple of years ago when they converted from an exclusive to a nonexclusive. And frankly we think that the team we have internally coupled with the additional products that we sell to that industry can do a better job of detailing those longer term. So, we're very optimistic about what we can do with those products and getting them back in the bag, so-to-speak, and capture that margin and maybe even capture some new customers as well. So, with all due respect to GE, it was a business that was somewhat increasingly given less and less attention to and we will certainly change that.

Okay. And last question, Brookwood, obviously they've had impressive revenue growth this year and the last couple of years, but is there anything more you can tell us just to maybe give us some increased confidence or visibility that some of the products in the pipeline could be material royalty generators several years down the road?

You know, we can't be that specific yet, other than just to say that the revenue they've generated to this point and the profit they've generated to this point has all come without revenue -- I'm sorry, without royalties or license fees or milestones, to speak of. So, this is a business that on its own has generated a lot of interest through a variety of different customers of all sizes in terms of R&D dollars. And, again, as we commented in the prepared remarks, eventually, before those products get commercialized, they'll need to take a license under Brookwood technology patents and know-how.

So, as we said, customers prefer to take early licenses or later license, the bottom line is they need to take a license at some point. And in that business what we're seeing is many prefer to take it after they've generated some good clinical data. That's fine, but, again, that typically results in a higher set of license terms than if they'd taken it before.

So, I think the things to watch in that business are growing revenue trends and the fact that the commercial R&D line in particular has been robust. And we expect there to be good R&D dollars in 2009 as well.

Okay. All right, that helps. That's all of my questions. Thank you.

Good. Thank you.

Thank you. Our next question comes from the line of Charly Jones with Barrington Research. Please go ahead.

Yes, hi. Thanks for taking the questions. So, in other word, Abbott was paying you too much in prior quarters and now they're catching up, is that right?

Well, it's just an accounting adjustment for some products. So, yes, there was a true-up that was in one of the customers under the Abbott umbrella, but the bigger effect is probably the seasonality.

Can you tell us what the total Abbott number is going to be in your 10-K?

Well, they're at 10%. I don't have the total figure, but -- so, that would be around $9.7

I thought when we had talked last quarter, a couple of quarters ago, you had said that this Abbott piece that's going away was less than half. So, it's actually much closer to the whole amount, is that correct?

No, we've not said how much it was of the total other than to say it was the largest single piece.

Can you describe the sales process for the immunoassay business and the need to add any salespeople there, or will you need to shift resources so that people are available in a sales capacity for those products? Or is it more of a pull demand?

No, we have an exceptional inside capability in the sales organization, which we've added to over the last few years. And we've got both domestic and some international coverage as well. We've got distributors, products outside the US, to some extent. It's fairly broad-based and it's something we're going to watch. If we need additional support, we'll certainly consider that.

Again, I would tell you that because we're broadening the bag of products to somewhat the same customer base, it in theory -- at some point this theory breaks down -- but in theory you shouldn't need additional people to cover those same customers or same group of customers. At some point you will, and frankly that's a good problem to have.

So, we'll watch it closely and adjust accordingly. But at least for now we believe we've got the right mix of capability in-house. And again we've had just exceptional work by our in-house team.

Can you give us a rough estimate of the GE royalty stream and how much you think this will generate in product revenue?

I don't have that off the top of my head.

So, what we're receiving from GE was two revenue streams, the royalty stream as well as the product sales, where we were selling the product to them and they were in turn reselling that to their customers. So, the only piece that we are tapping into now is that product piece where we're eliminating a distribution layer. The royalties obviously have gone away and that was an impact in the In Vitro (inaudible), but nowhere near the impact of the Abbott [launch].

Was there a partial quarter or was there a full quarter impact, and when did this -- remind us when this agreement ended and how many months you recognize revenue for from GE, your royalties?

We had some partial royalties in Q4, but most of the quarter was without.

Okay. I guess one of my final question is, well, actually before that, what was the dollar amount of the bonuses that were paid in '07 and in '08, or will be paid in '08? How much have you actually recognized as an expense in 2008?

I don't have that number in front of me.

The cash accruals are significantly lower than they were in '07, because the expected payouts under the incentive compensation plan, the cast portion, are not at the higher levels of achievement as they were in '07. I don't have the dollars in front of me that were --

I think it was something like $8 million in '07, is that right? And you were booking $2 million a quarter, I thought, in the first three quarters.

If you look at stock-based compensation, that was $10.3 million in '07, and $9.7 million in '08, and that, if you recall, there was a $1.3 million sort of catch-up charge, if you will, or one-time charge, excuse me, that was related to some of the transitions on our board of directors.

So, I guess one of my major issues here is that you guys are talking about your stock price being down and how you don't understand that given all the good things that have happened with Merck. And I guess, obviously, I don't think that takes into account anything about valuation across the market in healthcare or the market. And, number two, I guess I struggle to understand how bonuses could be paid when you have paid bonuses in the prior year on a Merck agreement that was canceled.

Well, I mean, I guess part of that answer relative to Merck is you either base compensation upon GAAP results or non-GAAP results, but you've got to give credit to the employees and the team involved in one of those junctions or not. So, the Oregon Comp Committee viewed it correctly, in my opinion, that you base the incentive comp on the non-GAAP results because, as you've seen, the GAAP results in Q1 are going to be substantial. But no one can justify paying a bonus based upon substantial GAAP results that result from termination of a Merck agreement. So, in one aspect it's got to be based on some consistent view of either GAAP or non-GAAP.

Secondly, our bonus, our incentive plan is the major portion of the compensation for the Officer Committee. Our base salaries are very low compared to the market, and we'll show that in the data in our fiscal 2008 proxy statement. So, we base incentive comp on financial results and nonfinancial results, and we think that there are a number of very positive financial results that have come out of fiscal 2008. But by now means are we paying a bonus anywhere near in 2008 what we paid in 2007, because, again, the Merck agreement was recognized mostly in 2007, and then we haven't achieved all of our goals in fiscal 2008.

Well, I guess that's what I don't understand, because you guys have been recognizing them quarterly over the last three quarters, and yet we really didn't see a decrease in the fourth quarter SG&A, which means you didn't do any catch-up to take back any of the bonuses you'd already reserved for.

Look, a couple of comments there, Charly. First of all, just to understand the way the Merck accounting is treated for incentive compensation purposes, in fiscal '07 the Oregon Comp Committee elected to consider the $20 million as part of the calculation. Any amortization of that $20 million upfront license fee that happened during the year gets backed out for calculations of the '08 pro forma revenue. And so it's only the cash that is brought in the door that is part of the calculation.

Okay, so to end that line of questioning, I just really have one more. You talked in your financial goals for 2009 as having one goal, one ophthalmology contract, and yet you were hoping for two in 2008, which means you're now just looking for the one from 2008, or that one was canceled and you have an additional one. So, I guess I would have thought we would have seen at least two, a goal of at least two ophthalmology programs. Can you tell us whether or not conversations have ended with somebody who is close, or have been extended to a point where you don't see it in the next 12 months for somebody that you thought was close?

Just to correct the '08 goals, you'll see them listed on the slide. We had a goal for one additional ophthalmology license, not two. And yet we still have customers in-house that are doing work with us today that would continue -- would like to continue to do the R&D work, and we'll see when the licensing discussions finalize. But as we said in the prepared remarks, eventually they're going to need to take a license and if they choose to do it later, ultimately that's their call.

I thought there were two licenses and one of them was the small particles that Merck had actually agreed to earlier in the year, and then there was a second one as well. But, so, I still don't understand. Did you have somebody who was close at the end -- that you thought was going to come in possibly sometime in September, October, November that has dropped out?

Yes, we've had more than one that was close. I can't talk in detail beyond that. But they haven't dropped out.

But they have not dropped out. Okay. And can we confirm whether it's in back of the eye or in front of the eye agreement that you're looking for? One of each?

No, we can't. No, we can't.

Okay, thanks.

Thank you. Our next question comes from the line of [Aaron Lindberg] with William Smith & Company. Please go ahead.

Thank you. Is advancing I-vation without a partner an option?

Advancing I-vation TA without a partner --

TA, yes.

It is an option. It's not a -- we haven't finalized that discussion internally yet. Not a highly probable one, but we haven't made the final decision internally yet.

Okay. And then is the drop in major nonlicensed opportunities related solely to Merck or are there other ones that have dropped off there? Last quarter it was 98, now it's 88?

Pipeline?

It's not just Merck, it's your normal ebb-and-flow that happens where we have influxes of projects that come in and then some that for lots of different reasons elect not to move forward.

Was Merck a substantial component of that, though, or were they just a couple?

Well, actually, in that bucket I don't think Merck was in that, because you're talking about non-licensed projects.

Okay. And since they took the license, they weren't falling in there even under some of the others that were coming in with Merck for proprietary things.

Right. It's not uncommon for that bucket to mix. I mean, it's earlier technologies, customers come and go for a variety of reasons.

No, and I understand that it may go down as things move through the pipeline, as they move from non-license to license as well. It just seemed like a bit of a big drop in the quarter that hadn't been addressed, so I just wanted to make sure there are not other things going on that we're not understanding.

Sure. Nothing abnormal.

Now, how long does the minimum royalty with J&J last? I know you made a comment that it's kind of through the end of the agreement. Is there a specific time frame that's set up on the agreement now and if they terminate early do they have to make a lump sum payment? What does that look like?

The details of the agreement are confidential, but they'll pay a minimum royalty as long as they need a license for the patent. And they'll need a license for the patent as long as they're commercializing the product using the technology someplace in the world, which is a long time from now, from what we've been told. So, we expect the minimum royalties to be in place for some time.

Okay. Sounds good. I think those are the key ones. Thanks.

Okay, thank you.

Thank you. Our next question comes from the line of Richard Rinkoff with Craig-Hallum. Please go ahead.

Thank you. You guys I think have actually given guidance for fiscal year '09, and it was for flat revenue and flat earnings, but could you please confirm which revenue and which earnings numbers you're talking about? Is it $97 million, is it $111 million? I'll start with that.

Yes, it's intended to be non-GAAP, so those were the $111 million, and I don't have the --

So $111 million of revenue, okay. And in terms of earnings, is it $0.80, is it $1.51, is it $1.05? What is it?

It would be the pro forma number, $1.51.

$1.51 in earnings. And -- okay. And that excludes what? How is non-GAAP different from GAAP in '09 other than the $44 million that Merck is going to pay you?

That would be the biggest difference, and then it would be any sorts of adjustments, if there are acquisitions with IP R&D charges or asset impairment, things like that.

So, just to be clear, $1.51 includes the cost of stock-based compensation, and it includes authorization on all acquisitions that we know about at the moment. However, would exclude a cost for the PR acquisition. Do I have that accurate?

That sounds correct, yes.

Okay. All right. What do you anticipate capital spending in '09?

We're still revisiting the total figure. The biggest investment we're making, of course, is in the Birmingham, Alabama manufacturing facility, and we're still looking at how much of that will be an '09 item as to spilling into 2010. Right now we'd probably bracket that between $20 million and $30 million in '09.

Okay. And on the PR Pharmaceutical transaction, what exactly are you buying? I read the press release, but are you buying something that looks like -- hang on, let me get the terminology here. Are you buying ProPhase, by any chance?

Yes.

ProPhase, and I think they also call the small particle technology FormEZE. So, we're buying assets, we're not buying the business. It's an asset deal including patents and patent applications, customer projects, and then an agreement with PR Pharma to actually do paid R&D work for their InsuLAR product including then a license back to them under their own -- under what used to be their own patent.

And how much revenue is likely to come from this transaction?

There will be revenue in fiscal 2009. We haven't specified that yet publicly, Rick. And again we'll be accretive excluding the deal cost.

But it's in your $111 million.

It is, yes.

If I go to PR Pharmaceuticals website and I look at ProPhase, which is what we've now decided is part of what you're buying, it says ProPhase is a delivery technology specifically designed for controlled release of frequently and often unstable therapeutic proteins and peptides. So, this dovetails in my mind, at least, with all of the other types of work you've done for back of the eye diseases. Does this kind of give you all the technologies that you would need to sign someone like a Genentech or any of the other guys, or is there still more stuff out there that you need?

You know, it's like a lot of technologies. There are pros and cons to everything. We actually have developed internal technologies. Brookwood has technologies that can formulate peptides and proteins, larger molecules. There are benefits and detriments to all those technologies depending upon the application, depending upon the peptide or protein.

So, I guess I can't tell you off the top of my head how many different protein or large molecule technologies there are out there, but this is one from PR Pharma that's different than the ones we have internally, and it potentially has some benefits that the ones we have internally do not. But I can't speak of specific customers other than to say this is very consistent with what we've tried to do with polymers, for example. We have a variety of different polymers in-house that can formulate large and small molecules, but by continuing to add to that bag, it just gives you added flexibility depending upon what the individual customer's need may be.

Okay, one more. I want to go back to the numbers for a moment.

Sure.

For you to go from $97 million to $111 million, you're not going to have Merck to help you, that's the assumption. So, that's $14 million of growth. And we know that CYPHER is going to go down, and Abbott is going to go down, and so are you suggesting that all other parts of the business are going to grow more than $14 million in '09?

I'm not sure -- where does the $14 come from?

You reported revenue this year of $97 million on a GAAP basis.

You're just taking the GAAP.

Right. And the difference between $97 million and $111 million was Merck, right?

Mostly, yes.

Yes.

So, let's just say it's $14 million of difference. You're projecting another $111 million year excluding any Merck payments, right?

Approximately. As I said, we've approximated that it's roughly flat revenue and EPS, and --

Okay, approximately. And we know that CYPHER is down and Abbott is down, so what you're saying is that you expect to make up at least $14 million of growth from the business. Am I reaching the right conclusion?

Yes. No, that's right. But, again, I can't break out what those pieces are other than just to say that was a bit of the focus of the prepared remarks. There are several things that are working in our direction including the acquisitions that we made with GE and PR Pharma.

Right. And there are no other acquisitions baked into that forecast?

No, that's correct, there aren't.

Right. Thank you very much.

Thank you. Our next question comes from the line of Daniel Owczarski with Avondale Partners. Please go ahead.

Good evening, gentlemen. It's Scott Freeman in for Daniel Owczarski. I've got a question as it relates to the Brookwood buildout. Do you have any update as far as how that's going or what your status is there? And what would be your first manufacturing contract there? Would it be the InsuLAR product?

No, actually we have a few that could be first, and I can't specify what those are, although certainly PR Pharm and InsuLAR is one of the likely products that would be manufactured out of that facility. It continues to go well. It's being managed extremely well by a very capable team down in Birmingham. It's a very large product for us, obviously, but I still say customers continue to be quite interested in that, and we expect to -- we are continuing to be -- we are still on time and within budget.

Can you remind us of what that timeline is again for completion?

Yes, it's I think the first expected milestone is in our third fiscal year -- or third quarter fiscal year 2009, and then we've got validation and some other qualification activities that are required to get it up to speed, to actually put products into it. So, likely the first -- products wouldn't go in until our fiscal 2010, early in our fiscal 2010.

And shifting focus for a moment on your prepared remarks on CYPHER you had mentioned that CYPHER sales are obviously driving lower. Are you pushing closer to your minimum royalty payment there? Have you reached that threshold? Any color you can give us on that?

Really can't. The minimum royalty payment is confidential. What we've said is it's in the millions of dollars on an annual basis. Beyond that, if CYPHER is going down, in theory it's getting closer, but we can't really talk about the quantification of that.

Thank you, and I'll jump back into the queue.

Thank you, and at this time there are no further questions. I will now turn it back to management for any closing remarks.

Good. Thank you, Operator, very much. We want to thank everybody again for participating in our conference call, and we look forward to speaking with you when we announce our first quarter results in January of 2009. Thank you very much.

Ladies and gentlemen, this concludes the SurModics Fourth Quarter 2008 Earnings Conference Call. You may now disconnect.